In this article, Arvind Subramanian contends that while Modi’s first Budget was good on vision, it fell short in terms of fiscal adjustment, budgetary transparency and credibility, and specificity and timelines on important policy actions. In his view, these shortcomings are remediable over time as the government forges the required political deals and improves administrative capacity to implement difficult policy actions.
Prime Minister Narendra Modi’s strategic vision, underlying his first budget speech, presented by Finance Minister Arun Jaitley on July 10, calls for an India that needs to grow rapidly and create opportunities for all. But while that vision deserves the highest of grades, the substance and the policy actions were not equal to the goal.
In substance, this was a budget prepared by incumbent bureaucrats, not incoming politicians. It represented continuity — which surprisingly was endorsed by much of the post-budget commentary — when the need of the hour was change. The following analysis focuses on macroeconomic rather than real sector policies.
Budgetary transparency and credibility
This budget offered an opportunity for the new government to come clean on budgetary accounting, even if this meant accepting the higher deficit number. It is widely accepted that there was a smoke-and-mirrors aspect to the numbers in the interim budget crafted by the previous government, which artificially reduced or deferred expenditures by up to 0.3% of the Gross Domestic Product (GDP). The budget should also have moved toward purging asset sales/privatisation receipts from the headline deficit number. Instead the budget continues these shortcomings.
Similarly, some of the budget numbers are implausible. Tax revenues are projected to grow by nearly 20%. That defies credibility given that nominal GDP growth is unlikely to exceed 13-14% (9% for inflation plus 5% for real GDP growth). It also defies credibility because already in the first quarter of this fiscal year, 45% of the annual deficit number has been reached. Strategically, it always pays to under-promise and outperform rather than the other way around, especially because this government has the luxury of a long time horizon for action.
More important, though, transparency and credible numbers evoke confidence. Unreliable numbers will eventually elicit cynicism. Good governance was supposed to distinguish this government from its predecessor, and the budget afforded an opportunity to reinforce this distinction. Imagine if the government’s first budget had established new standards of transparency and credibility, the government would have drawn gushing kudos, in the spirit of what George Orwell said of Mahatma Gandhi: “How clean a smell he has managed to leave behind.”
The budget is about more than headline deficit numbers. But fiscal policy is hugely important, and when correctly measured, this budget will either entail no fiscal adjustment or even some fiscal relaxation.
Such a relaxation would not normally be a source of concern and might even be warranted. But these are not normal macroeconomic times for India. These are unusually fragile times. Inflation is running at 8.5%, a rate that is among the highest in the emerging markets. Fiscal deficits are at 7% of GDP, and the current account deficit is at 2% of GDP, kept in check only by a growth collapse and controls on the imports of gold. A terrible monsoon is about to produce lower growth, higher inflation, and increased expenditures. Oil prices could soar because of global trends, and above all, asset prices, especially the stock market, have bubbled to such high levels that a small trigger could lead to capital outflows and a sharp, disruptive correction in asset prices. This budget needed to anticipate these contingencies by creating a cushion to withstand possible shocks.
More broadly, a basic misunderstanding is driving complacency in fiscal policy. The budget and its analysts alike have focused on the medium-term path of fiscal adjustment. This path is important but not critical. On fiscal policy, India has a flow problem, not a stock problem.
India’s debt-to-GDP ratio is not critically high and has in fact been going down because of high inflation, which has boosted nominal GDP. Inflation has been bad for consumers and savers but great for debtors and a bonanza for the biggest debtor of all, namely the government. On the other hand, the flow problem stems from high fiscal deficits keeping inflation high and the current account under pressure.
This distinction leads to different conclusions for fiscal adjustment. The stock perspective argues for modest and steady improvements in the deficit. But a flow perspective argues for greater and faster adjustment because of the fragile state of the macro economy described above.
Accordingly, the budget should at least have started reducing the aggregate fiscal deficit by 0.3 to 0.5 percentage points. Instead, the fiscal deficit might deteriorate further, moving in the opposite direction in light of India’s fragile situation.
Credibility of policy
The 2014 budget announced deficit targets for this year and for the medium term. But on two key issues — subsidies and the goods and services tax (GST) — specific actions and timelines were missing.
In fairness, the new government has had limited time to put personnel in place and prepare politically for the implementation of its policies to restore confidence and generate growth. That may yet happen. For now, observers and critics should be forthright in their assessment of the 2014 budget. But they should also give this government the benefit of doubt and time to translate its laudable vision into recognisable reality.